Federal Reserve Fires Back at Greenberg, Starr over Loan to AIG

The Federal Reserve Bank of New York Monday asked a federal court in Manhattan to promptly dismiss a lawsuit alleging that the federal government “discriminated” against American International Group by taking it over rather than loaning it money when it ran into financial problems in September 2008.

The suit was filed in November by Starr International, a Switzerland-based firm controlled by Maurice “Hank” Greenberg, former chairman and CEO of AIG.

A companion suit was filed in the Federal Court of Claims in Washington making the same allegations against the federal government and seeking $25 billion in damages for Starr and AIG shareholders, including Greenberg. The federal government last month filed an answer to that suit also seeking prompt dismissal.

The Treasury’s answer to that suit in the Court of Claims takes a softer tone than the Federal Reserve’s response filed yesterday by John S. Kiernan, a partner at Debevoise & Plimpton, LLP, in New York.

The Fed response says, “The complaint’s effort to portray AIG and Starr as victims entitled to be paid tens of billions of taxpayer dollars ignores that AIG created the highly dangerous conditions that left the Federal Reserve Bank of New York with no practical alternative but to lend massive amounts to AIG to avoid a potential market-wide catastrophe.”

The complaint should be dismissed without further imposition of burdens on the Federal Reserve Bank of New York, and, ultimately, taxpayers, the response says.

It adds, “Although the complaint downplays AIG’s plight as ‘a liquidity problem, not a solvency problem’, the ‘liquidity problem’ was gargantuan and threatened AIG with bankruptcy.”

The response further states, “The complaint concedes that AIG’s ‘attempt to find a private-sector solution failed,’ as private parties were unwilling to lend the massive amounts AIG needed even on terms that plaintiff now describes as ‘unfair’ and ‘stealing the Company.’

“AIG therefore informed the U.S. government, on the morning of Sept. 16 that AIG needed to consider bankruptcy, and sought a rescue from FRBNY (which had not previously exercised supervisory authority over AIG, an insurance holding company).”

The Fed answer explains in detail that AIG’s problems stem from its sale of credit-default swaps on mortgage-backed securities, as well as speculation in MBS by AIG’s securities subsidiary that collateralized the investment with reserves held by AIG’s life-insurance subsidiaries.

It was later learned that AIG was responsible for $2.77 trillion in notional amount of CDS at the time it sought Fed and Treasury help in September 2008.

The Fed’s initial aid was $85 billion in cash in exchange for 79.9 percent of AIG’s stock. The ultimate fed aid to AIG was $225 billion in cash through loans by the Fed and Treasury, plus other monies collateralized by securities held by AIG’s life subsidiaries as well as certain other insurance subsidiaries owned by the company that have either since been totally or partially sold.

In the answer, the Fed notes, “Despite acknowledging the urgent, dire and fast-breaking circumstances AIG faced, plaintiff remarkably complains that ‘the Government’ made an ‘unprecedented and rushed demand’ regarding terms for a rescue which was ‘based not on an individualized determination’ or an ‘independent analysis’ of the terms ‘reasonably necessary to protect the Government’s legitimate interests.’”

The Fed contends it “lent to AIG on essentially the terms that the private parties had rejected as insufficient given market conditions and AIG’s poor credit condition.

“Plaintiff apparently contends that AIG, despite having mismanaged itself into a massive liquidity crisis that required—as merely an initial step—an emergency credit facility of a staggering $85 billion, was legally entitled to receive terms and conditions from the Federal Reserve Bank of New York that were more favorable than the terms the private lenders had walked away from.”